Risk-weighted assets (RWAs) have become one of the most important yardsticks for bank CEOs. As the denominator in the capital adequacy ratio, it determines how much capital banks must hold to meet their safety and soundness requirements under Basel III.
The lower a bank’s RWA, the less capital it needs, freeing up funds for revenue-generating activities. It is no surprise that in recent years, many banks have sought to improve asset quality and reduce their RWAs, and this year’s Top 1000 suggests the strategy is starting to bear fruit. After two years of the global aggregate remaining relatively static, aggregate RWA fell 6.4%.
A perhaps more useful measure is RWA divided by total assets, otherwise known as RWA density. Comparing this year over year reveals which regions are making progress in not just shrinking, but also de-risking, their balance sheets. While RWA density has been drifting down at many of the systemically important banks for a few years now, this is the first time in three years that global RWA density has shrunk. The Top 1000 reveals which regions are leading the charge.
Central and eastern Europe (CEE) and the Middle East have both made strides in this area. Two years ago their RWA densities were 85.54% and 73.9%, respectively; more than 10% higher than any other region. In this year’s ranking their ratios are down between 133 and 110 basis points, meaning their RWA densities are no longer regional outliers.
For Middle Eastern banks, this suggests the plummeting oil price, which hit a 13-year low in 2016, has not damaged their loan books to the extent many had feared. The gains CEE banks made during 2016 are particularly notable. They have increased total assets by 13.2% but their RWAs are down 5.33%. This suggests banks are managing to grow their asset base, while also deleveraging.
Africa is another big improver. Its total RWAs are down 26% from last year’s Top 1000, a bigger decline than any other region. Its unweighted assets are down just 4.7%, giving it a RWA density of just 37.76%
China’s asset base has continued on the same trajectory for a few years now, with total assets growing about three times quicker than RWAs. Yet in 2016 it made big strides, reducing its RWA density from 61.43% to 56.34%. However, there are concerns that the world’s biggest banking market is not accurately recognising the quality of assets on its balance sheet. China’s central bank has started a crackdown on risky lending practices and is forcing lenders to increase loan loss provisions and recognise impaired loans. It will be interesting to see how this affects next year’s RWA rankings.
Meanwhile, in Japan banks continued to deleverage, reducing their RWA density to the global benchmark of 32.14%. Lenders across the rest of the Asia-Pacific region made a similar reduction, leading to a regional RWA that is just above the global average.
Western Europe continues its run as the region with the lowest RWA density. In 2016 total assets shrunk 3.4% while RWAs were down a whopping 14.6%, leaving a RWA density of just 31.9%. This reflects the trend of many European investment banks exiting or reducing capital-intensive operations, such as fixed-income, currencies and commodities trading and project finance, to boost profitability. Reduced RWAs is also a goal for those undergoing group-wide restructures.
It will be interesting to see whether RWAs change in next year’s rankings as a result of the Basel Committee’s refinement of RWA calculation rules, expected sometime in 2017. Today banks have the option of using standard market-wide risk weights or internal models they develop themselves, but Basel is considering whether to curb use of the latter.
If this happens, banks that favour internal models – including some of western Europe’s biggest lenders – could see their RWAs and RWA density rise. In turn, they would have to raise more capital.
